1.6.1 Revenue and Costs and 1.6.2 Their relationship Flashcards
what is sales volume and total revenue
- Sales volume: this is the number of items sold over a period of time
- Total revenue/sales revenue: this is the value of the business
calculations for salves volume and total rev
Sales revenue - price x quantity sold
Average cost = total cost quantity sold
Total cost = fixed costs + variable costs
Profit = total revenue - total cost
costs involves for a business
- Total costs: all the costs involved in producing a good or service
- Total fixed costs: costs that do not change with output (rent, business rates, managers salaries)
- Total Variable costs: costs do change with output (material costs, energy bills, wage costs)
- Average fixed costs = total fixed costs output
- Average variable costs = total variable costs output
direct and indirect costs
- Variable cost are sometimes called direct costs, as they are directly associated with output.
- fixed costs are sometimes called indirect costs, as they are not directly related to output
assumptions made when calculating profit/loss change + how to estimate this
To estimate sales → market research
Assumptions when calculating change in profit/loss:
- Fixed cost are fixed
- Costs per unit for VC are the same (flour is the same price etc)
percentage change
- Percentage change: the amount of change in a variable expressed as a percentage of the original amount of that variable
Change - original
——————— x 100
Original
contribution
Contribution is the difference between the price of a product and its variable cost P - VC
- Every time a product is sold, the contribution from its sale can be used to pay off the fixed costs of the business
- Once the break point is reached, the contribution from the next sale begins to create profit
Contribution per unit = costs per unit - VC per unit
break even point
- The break even point is the level of output at which the total revenue is exactly the same as the total costs → neither a profit or a loss is being made
- When output is above the break-even point the business will start to make profit TR>TC
- When output is below the break-even point the business will start to make a loss TR<TC
assumptions when doing break even analysis
- All other variables remain constant
- A single product is produced
- Costs can be divided into fixed and variable elements
- There is a linear relationship between output and total costs (variable costs per unit remain unchanged)
- There is a linear relationship between output and sales revenue (each unit is sold at the same price)
- All output can be sold at the given price
- The analysis applies to the relevant range only
- All stock is actually sold
explain the break even graph
- Fixed costs are shown on a horizontal line
- Variable costs are added to fixed costs
- Total costs start part way up the vertical axis, as there are fixed costs + variable costs
- Total sales revenue starts from the origin and rise in the form of a straight line
- Break even occurs at the intersection of total costs and total revenue
- We can read off both the break even quantity and break even revenue on the horizontal and vertical axis
- The gap between current output and sales and break even is known as the margin of safety
- The red triangle shows LOSS and the blue triangle shows PROFIT
** for BEP always round UP
** for BEP always use the name of the product (15,000 scarves)
contribution and the break even point
Break even point = total fixed costs
———————
Contribution (P-AVC)
- If costs go down, your likely to make a profit sooner because the BEP is lower
margin of safety
significance
- The margin of safety is the difference between the acual level of output and the break even level of output
- It shows how low sales can fall before the business starts to make a loss
- A higher margin of safety puts the business in a better position
- A business need to think about how to break even
- This will help clarify the risks and precautions that may need to be in place
- Eg better advertising strategies, or perhaps more freezer capacity
- Profit = margin of safety x contribution per unit
what is break even analysis
- Break even analysis means looking at the break point and seeing if a business venture will be feasible
- Different prices and costs can be considered to see how BEP changes, profit levels can be worked out over a range of output levels
- BEP will be a key element in a business plan if a business is trying to raise finance
strengths of BEP
- Helps to assess the strength of a business idea and whether it is worthwhile or not (planning)
- Helps to assess the levels of output needed to make a profit
- Shows the impact of changes in price and/or costs on the BEP and any profit levels
- Enables the calculation of profit/loss over different levels of output
- Helps support an application for finance
- Can be used in new product development to estimate sales needed to break even on a product
- Measures profits at different levels of sales
- Can identify the impact of price/cost changes
weakness of BEP
- The model assumes that costs rise steadily, but they may not → bulk buying can reduce cost per unit
- The model assumes that all output is sold, in reality this may not happen
- It is only a forecast and estimates of costs and price levels may be unrealistic
- Knowing what BEP ins doesnt mean you will actually sell all the stock manufactured
- Markets are dynamic so if estimates are correct something can happen to spoil things (competitions, economic recession etc)
- Does not take into account economies of scale and bulk buying
- Static model that needs to be reworked whenever one of the variables changes
